Commentary

Microsoft: Nothing to offer beyond the Dividend

Commentary: There are aspects to like, but not enough to buy.

Rockville, Md. (MarketWatch) — Microsoft is one of those stocks where there is no compelling reason not to own it. It’s a rock-solid stock that isn’t going anywhere and appears to be fairly valued.

On the other hand, there’s no compelling reason to buy Microsoft
MSFT, -1.65%
stock either. Even Microsoft bargain hunters will admit that it isn’t on the verge of a breakout or a new product that will catapult it back to prominence.

So while the downside is limited, the upside is limited just as much — if not more. So any logical investor should ask, “Why bother?”

To be clear, I’m not one of those post-PC bears who thinks Microsoft is doomed. I believe Microsoft will be around for many years to come.

But that’s vastly different than thinking the stock is a good buy that will outperform the market and is a good investment compared with the alternatives.

In case you’re not familiar, the typical case for Microsoft goes like this.

Valuation: The valuation is more than fair, with a price-to-earnings ratio of 9.7 according to Standard & Poor’s fiscal 2013 forecasts of $2.88 in EPS. Use full-year 2014 forecasts of $3.11, and you get close to 9.0.

Cash: Microsoft has $66 billion in cash — enough to buy both Hewlett-Packard (HPQ) and Dell (DELL) combined. Even though almost $58 billion of that is overseas and could be subject to taxes if repatriated, that’s a huge chunk of change.

Windows Isn’t Dead: Windows and Office remain dominant and profitable. While tablets are ascendant, desktops and laptops will remain necessary to the workplace in some form for many years.

Sleepy But Profitable Products: While Bing or the Windows Phone or Surface lack the dominance of Windows, that doesn’t mean they are failures. Sure, they may never have a cult following, but that doesn’t mean they don’t make money.

Dividend: Microsoft has more than doubled its dividend in the last five years to 92 cents annually — a roughly 3.3% yield — and the payout ratio is a very sustainable 31% in fiscal 2013 that could signal further continued increases in years ahead.

The dividend is indeed attractive, I’ll give you that, and it has the potential to move higher. But is there anything on the list above that actually sets it apart — in the tech sector or otherwise? And what gets you excited for this stock, or hopeful for its future growth?

Some contend it’s the value proposition, that the market is undervaluing the tremendous cash hoard or the bulletproof cashflow. OK, but then why hasn’t this argument managed to catch on for the last 12 ... 24 ... or 36 months?

Remember, Microsoft has been dead money for a decade. Barring a three-month run in late 2007 and a few weeks in 2012, MSFT stock has failed to break north of $32.

And there’s no reason that will change anytime soon.

I suppose you can play the churn, buying in the mid-$20 range and hoping it gets back to the low $30s in a year or so. If Microsoft gets into the $26 range, I may consider it myself. However, that’s not the same as acting like Microsoft has staying power.

That’s because long-term investors have to deal with the following downside risks offsetting the rather lackluster bullish case for MSFT:

Mobile miscues: Microsoft pulled out all the stops on Surface and Windows 8 in an ambitious (some would say desperate) bid to offset the PC decline with a footprint in tablets. Unfortunately, its first quarterly results that include Windows 8 showed a similar trajectory to Windows 7 and didn’t impress anyone.

Furthermore, Microsoft hasn’t yet confirmed Surface sales totals, saying they are “modest” at best, and many fear that Surface Pro is grossly overpriced at as much as $999 for the flagship model. Sure, some think Surface and Windows 8 may offset lost PC-based revenue. However, with 2012 PC sales marking their first decline in over a decade, Microsoft has a great deal riding on mobile success — and not a lot of time to figure it out.

Bad leadership: Steve Ballmer has been CEO since 2000, when the iconic Bill Gates stepped down, and he’s long overstayed his welcome. I’m not talking about rumors that he fires internal rivals to maintain power or the obvious late arrival to mobile, either. I’m talking about a general focus on the Windows upgrade cycle and stock buybacks without any heed to broader tech and business trends.

Consider that Microsoft had 10.8 billion shares in 2004 — and now it has 8.3 billion. That’s over $60 billion in buybacks and the share price hasn’t budged. Consider the latest creative plan to throw in with fellow also-ran Dell, an ill-advised scheme with little upside beyond protecting a big downstream customer. Sure, firing Ballmer may give a short-term pop … but truly fixing this mess requires a culture change and influx of new talent at all levels, not just a new face.

Old-guard tech stocks have a poor track record: One last warning: While tech stocks are theoretically the lifeblood of the S&P 500, with 18% of the index weighted in this sector, that doesn’t mean all IT stocks are good investments. Many blue chips in the sector continue to disappoint since the financial crisis.

From January 2010, after the initial rebound from the bear market bottom, the S&P 500 is up over 37% in the last 36 months; however some of the biggest names in tech have not just underperformed but are in the red. Hewlett-Packard (HPQ) is down 65% — but even barring this unique dumpster fire of a tech company, Cisco (CSCO) is down 6%, Juniper (JNPR) is down 11% and Microsoft is down 4%. Countless others have failed to match the broader S&P — including Intel (INTC) and Google (GOOG) to name a few.

You probably are thinking of a few stocks that have bucked this trend — but that proves my point. Why settle for Microsoft when there are alternatives? Clearly banking on tech generally — which is essentially what you’re doing with a Microsoft value play — doesn’t always work out.

To be clear, I’m not saying that Microsoft is a bad stock. A secular bull market or a recovery in enterprise spending will benefit this pick. But it will also benefit many others, so I fail to see the compelling reason for MSFT above its peers.

I’m fairly sure that buy-and-hold types can hold it for 20 years at a 3.5% annual return and end up doubling their money. That’s not a bad thing, per se. But remember that simply buying an indexed fund like the SPDR S&P 500 ETF Trust (SPY) may deliver similar — or even bigger — returns in the long term than MSFT.

Microsoft may be stable. Microsoft may have long-term potential. But that hardly makes it unique.

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